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In April this year Vedanta announced a non-cash impairment charge of acquisition goodwill to the tune of about Rs 20,000 crore in 2014-15, possibly the biggest write-off by an Indian company, citing an unprecedented fall in oil prices.A month later, Tata Steel announced a Rs 6,500 crore goodwill impairment charge for the loss of value of operations in Europe, Canada, and Mozambique in 2014-15.
This was the second write-down for Tata Steel in the past two years. In 2013, the steel major wrote off $1.6 billion (then pegged at around Rs 8,700 crore) on its European operations due to a weak market environment. Analysts tracking the company note the successive write-downs are largely the fallout of an expensive purchase.
Tata Steel bought British steelmaker Corus at the peak of the commodity cycle in 2007 for $13 billion.
There are half-a-dozen Indian companies that have announced similar impairment charges in their fourth-quarter results for 2014-15. Indications are that corporate India's cumulative write-downs in 2014-15 are likely to be highest since 2010.
Typically, impairment is used to account for any fall in the carrying value of an asset, or a group of assets, over its recoverable amount, which is the measure of its cash flows over the balance of its useful life or sale. "An impairment of such assets is more in the nature of an accelerated depreciation or amortisation that is over and above the usual depreciation charge," says Shyamak Tata, partner, Deloitte Haskins & Sells.
Impairment may arise due to adverse impacts on cash flows from obsolescence, technology changes and changes in market conditions.
While there are established procedures to account for impairment, such calculations are inherently subjective, based on assumptions over extended periods, say tax experts and chartered accountants. The big challenge for an auditor is to ensure the charge is recorded in a timely manner. Management decisions are likely to come under scrutiny following the announcement of a big impairment charge.
To mitigate any impact on brand reputation and even the stock price companies must clearly convey to all stakeholders the reasons for the charge, say experts.
Though there have been no similar cases in India, auditors and tax experts warn large write-offs could reflect on the enthusiasm of the buyer or even misrepresentation on the part of the seller.
"In the Indian context, it often indicates misuse of accounting practices resulting in overcapitalisation of pre-operative expenses and interest costs," says Pallav Pradyumm Narang, partner in chartered accountancy firm Arkay & Arkay.
Auditors need to constructively challenge assumptions used by a management making a case for impairment, says Jamil Khatri, partner, KPMG. "The challenge for auditors is to justify why there is no impairment of an asset," he says. Getting the timing "right" is also important.
"As impairment charges are unusual and large, companies must clearly communicate more with stakeholders," says Tata. This is one area most auditors and tax experts agree Indian companies need to work on.
While performing a thorough due diligences of the financials of a target company, businesses need to focus not just on the quantity of the earnings, but also the quality, says Narang. With India adopting the International Financial Reporting Standards(IFRS)-compliant accounting standard IndAS from April 2016, treatment of impairment in the books will also see some changes. In IFRS an impairment charge once imposed cannot be reversed. "This is particularly relevant for impairments related to commodity cycles because such cycles may turn resulting in increase in business value in the future," says KPMG's Khatri. IFRS requires a management to disclose the assumptions on which an impairment has been made, along with a sensitivity analysis. This is not required by Indian Generally accepted accounting principles (GAAP). Moreover, the use of fair value in IFRS captures the current valuation of all assets acquired.
"This results in increased depreciation and lower carrying value of the acquired business. That may not be the case in Indian GAAP due to use of the book value," says Khatri. Accordingly, a subsequent decline in value may result in a larger impairment in Indian GAAP, he adds.
According to Rakesh Nangia, managing partner, Nangia & Co, a chartered accountancy firm, IndAS requires goodwill and intangible assets to be tested for impairment annually. In Indian GAAP, goodwill and intangibles are tested for impairment only when there is an indication that they may be impaired, he adds.
